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ESG: balancing the risks and opportunities in asset management

ESG (environment, social, governance) is now commonly defined as an asset class, and it is something the buy-side community need to factor into their portfolios. In fact, a study by BNP Paribas Securities Services’ – Great Expectations: ESG – What’s next for asset owners and asset managers? – found that 79% of respondents incorporate ESG, either in how they invest as asset owners, or in terms of the products they market, as asset managers.

ESG’s growth is down to several factors:

  1. Institutionalisation. Institutional allocators have come under pressure from active stakeholders about some of their investments, which have been criticised for being opposite to ESG principles. In turn, institutions are telling asset managers to become more observant of ESG practices. Of the asset owners that adopt ESG, nearly half have 25% or less invested in ESG, although this is likely to increase to over 50% in the next two years.
  1. Millennials. It is not just institutions who are demanding managers prioritise ESG, but retail clients as well. According to Schroders, millennials are far more interested in ESG matters than older investors, and likelier to redeem capital from companies which do not support ESG or that have poor ESG records. In fact, the Schroders report acknowledged millennials rated ESG outcomes as highly as investment outcomes. As millennials start collecting their inheritances and rising up the employment ladder, this demographic will need to start investing to enjoy wealth accumulation. The forward-thinking managers have already recognised this and will be exploring ESG.
  1. Governments. Another more recent driver of ESG investing has been governments. Both the UK and France have committed to ban petrol and diesel vehicles by 2040. Long-term investors and managers holding equity positions in car manufacturers will certainly be reviewing their holdings, and may dis-invest if they feel insufficient efforts are being made in the development of electronic, carbon neutral vehicles, for example. Policy changes are pushing fund managers to consider ESG friendly investments, and this trend shows no sign of stopping or slowing, at least on this side of the Atlantic.

A number of managers have expressed concern about the costs associated with ESG, and its impact on performance. Some have argued that adopting ESG prescriptively could undermine their ability to select promising stocks, forcing them to divest from potentially lucrative opportunities.  While there is certainly some truth to this statement, data does suggest companies which embrace ESG deliver greater value to shareholders. Admittedly, the notion that ESG outperforms non-ESG investments has to be taken with a pinch of salt for now, mainly because there is not enough historical data.

FUNDFORUM GLOBAL ESGNonetheless, there is logic in arguing ESG’s performance case. Good governance equates to good business practices. Corporate bankruptcies or underperformance are all unique, but a common theme at many has often been poor or piecemeal governance. Those organisations where senior management is routinely held to account and have their performance and decision-making regularly scrutinised by engaged directors tend to be well-run, and deliver shareholder value. The opposite is true when boards are timid.

On the environmental front, huge innovations are being made in renewables, in what is likely to put the sword to traditional heavy-pollutant industries in the years to come. At the same time, owning an asset or commodity which is likely to be banned by governments in the coming decade is going to result in a dramatic price fall. Simultaneously, companies which take a positive environmental approach are likely to enjoy greater energy efficiencies thereby keeping costs down.

A socially responsible company may be one that offers fair remuneration, flexible working arrangements or generous staff healthcare. Having a positive workforce environment is critical to a company’s success whereas those which routinely fail their staff tend to have higher turnover rates or more frequent disruption through strike activity.

For managers, an ESG framework is something investors want and it is a performance enabler. As investors become more conscious about the contents of their portfolios and governments promote a sustainable agenda with greater alacrity, managers are going to have to change their business approach, and this will include upping their ESG game.

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